Private debt has enjoyed unprecedented growth across Europe in recent years, but a breakthrough in one key economy remains illusive. Germany’s large and fragmented banking market means opportunities for debt funds are slim.
The country’s Mittelstand is fertile ground for mid-market lenders, but breaking into that territory remains difficult when the local banks, which have long-term relationships with these companies and have a cheaper cost of capital, remain active.
Banks, however, are struggling, and a wave of consolidation is expected across the sector driven by low interest rates compressing cash deposits and regulations restricting commissions from more complex acquisitions. But while PwC predicts a capital shortfall for German banks of between €5 billion and €8.5 billion, debt funds may still struggle to increase their market share – at least in the short term.
Deloitte’s Alternative Lender Tracker has recorded 101 deals completed by private debt funds in Germany – less than half the number completed in France and less than a third of that in the UK. While estimates place the market share of alternative lenders at around 25-26 percent at the end of 2016, from a standing start only a couple of years ago, there is an expectation that this proportion will stall.
Unitranche structures across Europe, one of the more favoured instruments for acquisitions, rose to 102 in 2016, according to advisory firm GCA Altium – an 11 percent increase on 2015, but a steady slowing of the numbers compared with 2014, when there was a 37 percent increase.
Both France and the UK saw increases, yet Germany bucked the trend as deals dropped from 16 to 12. GCA Altium says the fall is explained by the “fact that banks have become more aggressive with respect to financing terms, as well as on covenant structures and other documentation issues”.
Banks which traditionally provided a revolver within the unitranche structure are also increasingly participating in the first loss, second loss structures. As a result, GCA Altium expects debt funds’ German market share to stagnate rather than show the growth pattern taking place in the UK and France.
So what can debt funds do to pick up the pace?
“Banks will remain active lenders in the German market,” says Jan Henrik Reichenbach, the recently appointed Muzinich head of DACH private debt. “Our approach is not to disintermediate them, but to either be a partner in situations where the underlying risk does not allow banks to be active anymore or to replace them for the same reason by offering a more flexible, customised solution.
“Debt funds have been initially seen in sponsor-backed transactions, where a more flexible approach typically resonates well with a private equity investor who, as an active shareholder, usually has very specific plans for value creation within portfolio companies.”
Debt fund finance can also expand into different parts of the market. Refinancings and dividend recapitalisations are pushing borrowers to tap into debt fund capital and one market source reports seeing a private debt fund provide a senior loan to refinance an existing unitranche facility.
Mark Brenke, co-head of private debt at Ardian, says his firm is open to providing debt to a myriad of situations as long as the fundamentals are solid.
“Refinancing situations are something that we do, but ultimately as a debt provider the main criteria upon which we base how much debt a business can support is the debt capacity of the business,” he says.
“If a business has delevered successfully since the original transaction and there is the ability to provide follow-on financing, then it is something that we should absolutely look at.
“We would not say we will not do refinancings or recaps – it’s more nuanced than that. We will do that throughout different market environments.”
Indeed, the spate of refinancings taking place in the last 12 months is a result of strong liquidity in the market. After being unable to find a buyer for chemical company HCS Group last November, HIG turned to GSO Capital Partners to provide a €340 million loan to refinance the debt. This followed an auction that attracted bids from Bain, Triton and Bridgepoint.
But there may be evidence of market overheating as borrowers take advantage of the huge amount of debt available to obtain better terms – a trend that becomes more pronounced as private debt funds in the European market raise larger funds and come under pressure to deploy the capital within a three-year investment period.
The ability of debt funds to provide customised solutions to prospective borrowers will be a source of long-term success for managers. While banks and alternative lenders appear to encroach on each other’s territories, many anticipate debt providers will offer very different options in the future.
“A fund-driven market will develop in the future, and will be distinct from the bank market.
“The fund market will be able to provide financing across the whole capital structure and a number of different financing structures, and price that accordingly. Alongside that you’ll have the bank market focus on their segment of the market,” Brenke says.